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Overpaying for “Toxic” Assets

By Matthew Yglesias on March 6, 2009 at 11:28 am

"Overpaying for “Toxic” Assets"

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As a number of people have noted, Geithner/Bernanke (and not to let them off the hook, either—Obama & Larry Summers) seem oddly determined to believe that the “toxic” assets held by banks are actually worth far more than the market is willing to pay for them. Being something of a believer in free markets, I’m not really sure I even understand what this means. Financial instruments are worth what they’re worth. There’s this idea that government policy could cause their market price to “become” what their true value “really is.” But the only way for this to work is for the government to just decide to pay a lot of money for them. Then they’d be “worth” whatever the government decided to pay. My understanding based on a conversation today, however, is that this is exactly what Geithner doesn’t want to do. He wants the private sector to set the price of the assets. But the private sector has already done this and deemed them worthless. So Geithner wants a plan that somehow induces the private sector to set the price at the level he “knows” is “right” somehow without actually doing this.

Noam Scheiber says:

As Krugman points out, there are only two places to go from here: You either way overpay for the assets by heavily subsidizing the investors who buy them, which doesn’t seem fair. Or you pay the fair price but leave a huge hole on the banks’ balance sheets. Neither option seems especially appealing.

I guess where I part company from Krugman is that I’m willing to accept some unfairness if it’ll solve the problem. I just don’t think Treasury can make the subsidy large enough for the overpayment to suffice. (Alas, the political constraints are enormous.) So, increasingly, nationalization looks like the only option.

I think the idea that it’s merely “political constraints” that prevent the giveaway option from working is, itself, becoming an obstacle. There seems to me to be too much time and energy already being spent on trying to alter the optics around a giveaway. Basically, some people are looking for a way to make a giveaway not look like a giveaway in an effort to address the political constraints issue. But I think there’s a larger problem of substance. Even once you accept the “big shitpile” theory of the case, there’s still uncertainty around how big and how shitty the pile really is. When you have the taxpayer accept the downside risks via nationalization, one thing you get is absolute credibility that all the risks no matter how bad they may be, are really being borne by the government. The only alternative would be to default on the national debt. Then you can do whatever you need to do, relaunch whatever you need to relaunch, and whatever comes out of the cleansing process will both be and be known to be a “good bank.” If you just try to do giveaways, it’s not clear to me how you make it clear to potential investors and counterparties that you’ve really given enough away. This is especially true if you try to address the political constraints via shell games designed to trick people into thinking that the giveaway isn’t a giveaway.

That kind of obfuscation is going to wind up with a situation in which you have the same unreliable people running the same banks claiming that their operations are now sound. But that’s what they’re claiming now! That’s what they were claiming a week ago! Nobody’s going to go into business with them. And nobody’s going to compete with them either, since they’re operating under hazilly-defined government guarantees.

The is the sense in which Obama is most likely to fail by being too cautious rather than overreaching. There are a number of things—including the libertarian/populist idea of just letting the banks fail—that seem risky, terrifying, and might work. And then there’s the “muddling through” option that’s less terrifying but also certain to fail. A number of people have noted over the years that Obama mixes a progressive agenda with a small-c conservative temperament. Which is, I think, normally a good kind of temperament. But I don’t think it’s a temperament that’s well-suited to this situation.

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